The following article by well-known Brisbane based property researcher and commentator, Michael Matusik, presents a strong case for against the often published claim that Australian property is over-valued. Michael’s argument questions the use of an overseas prices to rent formula for assessing values:
The most overvalued in the world!
It seems that at almost every turn these days we are subjected to another ludicrous report, finding or headline. The latest is from The Economist, which last week issued a report purporting to demonstrate that Australian house prices are the most overvalued in the world. The proposition is based on a prices-to-rent formula developed for overseas markets.
It should be noted that The Economist has been getting it wrong on Australian house prices since their global house price index started in 2002; but dismissing their claim based on this bias, whilst fast and easy, doesn’t really cut the mustard. There is little doubt that Australian housing is expensive, affordability is low and current values are high when compared to household income. But that doesn’t equate to a housing crash; nor does it mean we have the most overvalued homes in the world. In the world!
Why? Because The Economist’s ratio of average house prices to average rents model is seriously flawed. According to The Economist our houses – based on their price-to-rent ratio – are overvalued by 56%, followed by Hong Kong by 54% and 48% in France. According to the journal, Australian house prices have risen by 215% since 1997.
This raises some interesting points.
Firstly, and somewhat obviously, rents have not risen anywhere near as fast as end prices. This supports our thesis that Australia’s residential market, when measured correctly, is not as undersupplied as most believe. Hence rental growth remains subdued. Why, then, have prices risen so much when compared to rents?
There are several logical reasons why this has occurred, the sum of which dismisses The Economist’s claim.
Close to 70% of Australia’s dwellings are held by owner-residents, of which half are owned outright. A third of Australia’s dwellings are held by investors and are rented out.
We can sell our principal place of residence tax free. Investment property is subject to capital gains tax.
Two thirds of the Australian housing dollar is spent on renovations, a trend which has accelerated since the introduction of GST on new dwellings about a decade ago. Close to 80% of this renovation money is spent on owner-occupied homes. Very little is spent on improving investment dwellings. Improvements to Australian investment property are done to increase the rental return, not necessarily the sales price. Given the current tax laws, it makes good economic sense for owner-residents to improve their homes. Hence there is a large difference between the price of owner-occupied homes and investment property across Australia.
Whilst gross rental yields are on the slide, they still are in the mid-to-high 4% range – depending on dwelling type and location – across Australia. The median weekly rent Downunder is about $425 per week, suggesting that many rental properties sell for prices in the mid-to-high $400,000s. Most owner-occupied properties sell for much more, with close to 70% selling for prices over $500,000 and near to 40% selling for in excess of $600,000.
A quick survey of twelve suburbs across Brisbane found the following results. Within the inner city (5km from the GPO) dwellings sold by owner-residents in 2010 attracted a 20% to 25% premium over investment property sold in the same location and during the same year. This ratio was between 15% and 18% for middle-ring locations (around 10km from the CBD) and 8% to 10% for the outlying suburbs (about 20 km from the Queen Street Mall).
Owner-residents generally prefer detached houses over attached stock. The reverse is true for investors. Attached stock is, more often than not, cheaper than detached housing. More renters live in attached stock than detached product. This further exacerbates the reason why end prices – when pooled together – far exceed rents in this country.
So there is little wonder that the average price of Australian houses is much more than the average rent. Our rental stock is inferior – for the most part – to the dwelling stock held by owner-residents. A simple drive around any of our cities will illustrate such. It is a pity that some sections of the media, before jumping on the reprint bandwagon, don’t stop and think about what they are regurgitating. A simple look outside might explain a lot more than some report authored in Hong Kong.
PS And how do you figure this? Apparently we have the most overvalued homes in the world, yet whilst nobody really noticed, we pipped Norway, late last year, to have the highest standard of living in the world too. You just don’t know what to believe anymore.
This report is republished with permission of Matusik Property Insights.